Last Friday, the jobs report was released and, by most measures, it was great news. Jobs rose by 313,000 and the unemployment rate remained near 4%. This was the strongest report in 18 months, leading many to believe that the stock market correction was much ado about nothing. In fact, as of Friday, stocks had recovered 70% of the correction. Let's examine the economic data and what to watch out for to understand where we may go from here.
One of the best parts of the jobs report last Friday was the improvement in construction and manufacturing payrolls. They were up 61,000 and 31,000, respectively. This kind of growth suggests that there are real changes taking place in the U.S. economy. While many are quick to point to tax reform as the catalyst, we believe that is only part of the story.
Last year, the U.S. economy grew at an average rate of 2.3%, up from the 1.5% growth rate in 2016. Fiscal stimulus in the form of deregulation, higher government spending and the tax reform here in the U.S. and abroad, led to the improvement in growth around the globe. While we view this as good news, we are also aware that this fiscal stimulus is being added to a global economy which still benefits from monetary stimulus, i.e., developed country central bank balance sheets that are near their all‐time highs. This is a lot of fuel, both fiscal and monetary, to achieve a meager 2.3% U.S. growth rate.
This suggests to us that the longer‐term secular trends dampening growth and inflation are more powerful than some might believe. In the U.S., that includes the retiring population and subsequent but slower rise of the replacement millennial generation. Weaker consumer earnings growth is also a factor. We know that 70% of our economy is based on the consumer. While 20% of the workforce has seen wage growth from the economic recovery, 80% has seen real wages remain stagnant. To the extent that job creation begins to finally push average hourly earnings growth higher for that group, consumption, and therefore economic growth, may benefit this year.
In last Friday's jobs report, average hourly earnings grew at 2.6% over the prior year. However, when looking at the three‐month average, we remain at 2.9%, so nearer‐term that suggests some new strength in earnings growth and a boost for those consumers. In addition, the participation rate in the labor force rose, suggesting that more people who haven't been looking for work are coming back to the job market, which could also raise income.
On the inflation front, the secular trend regarding price discovery continues to hamper the growth rate of core inflation. (I know it is alive and well due to the number of packages arriving at my house in advance of a southern spring break–remember when we went to the store for sunscreen, flip flops and sunglasses? Now it arrives at our door step.)
Still, the combination of fiscal and monetary stimulus will fight against the dampening effect of price discovery, and we could see a greater resurgence in inflation expectations during the first half of this year. However, there are some signs that those higher expectations won't be fully realized.
Two of the biggest components of inflation–energy and housing–have risen at rates well above average. However, the increase in oil prices has led to a resurgence in energy production in the U.S. Oil production in this country is expected to surpass 10 million barrels per day, a level not seen since the early '70s. This should stay the attempt by OPEC to protect market share by cutting production to raise prices and instead lead to a stabilization in energy prices which could dampen the effect on energy price inflation in the third and fourth quarters of this year.
The Case Shiller U.S. National Home Price Index rose at a rate of 6.2% in 2017. As of the end of February, the year‐over‐year growth rate was 5.4%, reflecting a slowdown in the rate of growth. However, this is still almost 4% points higher than the core rate of inflation in the U.S. This may be a function of the increase in interest rates (the 10‐year Treasury was about .3% lower at this time last year), and higher rates could be a factor in slowing the inflation rate for housing.
Even though housing and energy inflation may decline, the amount of regulatory and fiscal stimulus may raise the specter of inflation to a level not seen in several years. As a result, the market may begin to reprice fixed‐income assets by increasing yields. To date, the rise in intermediate interest rates has been subdued. The 10‐year Treasury trades below 2.9%. However, with faster growth and the potential for an inflation warning signal, we expect yields to move higher. While we don't foresee the major sell‐off in the bond market some are calling for, we like the idea of shortening our portfolios' average maturity ahead of this move.